Financial markets have been rocked this week by a crisis emerging from the Chinese property market, with Hong Kong-listed developer Evergrande close to defaulting on around $300bn (£220bn) of debt.
Evergrande shares have plummeted more than 80pc and investors are worried that a collapse would send shock waves through stock and bond markets, and have serious implications for the Chinese economy.
This comes against the backdrop of the Chinese Communist Party taking steps to rein in the power of its leading companies, a move which has sent Chinese stocks tumbling this year prompted fund managers to label China “uninvestable”.
We explain the crisis and reveal what investors can do to protect themselves.
What has happened?
Chinese property has boomed since the communist country began integrating into the world economy after it joined the World Trade Organisation in 2001. Fuelled by debt, economists have warned of a bust for years that has never come.
As far back as 2016, Chinese president Xi Jinping teased a potential crackdown, saying “property is for living in, not for speculation”.
Despite vacancy rates of over 20pc, the tendency to overbuild in a country of party officials eager to show rapid regional growth – and gain their next promotion – is also behind the phenomenon of “ghost cities”: urban areas filled with half-finished concrete shells.
As the price of new build property slows to its weakest for five months, bad debts from the sector held by China’s banks have also grown. That has fuelled concerns over financial contagion and a global economic crash if China’s growth were to slow; the country’s property sector consumes around a quarter of the world’s iron ore.
Financial markets around the world reacted badly this week but have since rebounded. The S&P 500 basket of America’s largest stocks fell 3pc on Monday but has since recovered and is now just 3pc off its all-time high. The FTSE All Share fell 2pc but is back near all-time highs. Bitcoin crashed 13pc but has recovered a third of its losses.
What happens next?
Dubbed China’s “Lehman Brothers moment” by some analysts, a reference to the collapse of America’s fourth largest investment bank in 2008 because it owned housing debt that went bad, there is fear in some camps that an Evergrande default would have knock-on effects for global markets.
However, others argue the Communist Party would step in to prevent a default, and even if it did not then the impact would be subdued.
Richard Bernstein, of investment manager Richard Bernstein Advisors, said investors should not be worried.
“The Chinese economy has been very levered for a long time, and government officials are well aware of this. I expect there will be some sort of bailout for domestic bond holders and the government will punish the company for its poor management,” he said.
Simon MacAdam, of consultancy Capital Economics, said the “China’s Lehman moment” narrative was wide of the mark and a default would have very little global impact.
“Even if it were the first of many property developers to go bust in China, we suspect it would take a mistake from the government for this to cause a sharp slowdown in its economy. In a worst-case scenario, emerging markets are vulnerable. But in general, the global impact of swings in Chinese economic growth is often overstated,” he said
He added that some international investors would suffer as $18bn of Evergrande debt is issued in American dollars, but the amount was not large enough to have global implications.
What should you do?
Mr Bernstein has been reducing his investment in Chinese stocks because he thinks there are better opportunities in America and Europe.
“Our holdings peaked at about 14pc at the start of 2020 but are now only about 1pc of portfolios. China is about 4pc of the global equity markets,” he said
DIY investors can limit their investments by selling any China funds they own, such as the £2.3bn Fidelity China Special Situations, which has fallen 15pc this year.
For investors who still want to own stocks in emerging markets, fund group Lyxor offers the Lyxor MSCI EM ex-China ETF, which, for 0.25pc in fees, tracks the performance of stocks in emerging markets excluding China.
Some active stock pickers investing in Asia also avoid China. Pacific Assets Trust has only 9.7pc invested in Chinese stocks, while the Stewart Investors Asia Pacific Leaders Sustainability Fund has just 7.5pc.
Investors can also buy global trackers that avoid Chinese stocks, but must look out for those classed as buying stocks in the “developed world” rather than “all world”. For example, Vanguard’s FTSE Developed World ETF has nothing invested in China, while its FTSE All-World ETF has 4pc there. The version without China has returned 1.7 percentage points more this year.
But contrarian investors might smell opportunity. Chinese stocks are now in bargain territory, with top tech shares Tencent and Alibaba down 40pc from their peak this year. They trade at price-to-earnings ratios, which measure how cheap sharers are relative to profits, of about 19, which is about half the level of American rivals.
They could look at Scottish Mortgage, which has 17pc invested in China. Emerging markets trackers, such as the iShares MSCI EM ETF, have about has about 35pc in China, while “pure play” funds include the Fidelity China Special Situations and JPMorgan China Growth & Income investment trusts.